Subject: Strategy - Dollar Cost and Value Averaging

Last-Revised: 11 Dec 1992
Contributed-By:
Maurice Suhre

Dollar-cost averaging is a strategy in which a person invests a
fixed dollar amount on a regular basis, usually monthly purchase of
shares in a mutual fund. When the fund's price declines, the investor
receives slightly more shares for the fixed investment amount, and
slightly fewer when the share price is up. It turns out that this
strategy results in lowering the average cost slightly, assuming the
fund fluctuates up and down.

Value averaging is a strategy in which a person adjusts the amount
invested, up or down, to meet a prescribed target. An example should
clarify: Suppose you are going to invest $200 per month in a mutual
fund, and at the end of the first month, thanks to a decline in the
fund's value, your $200 has shrunk to $190. Then you add in $210 the
next month, bringing the value to $400 (2*$200). Similarly, if the
fund is worth $430 at the end of the second month, you only put in
$170 to bring it up to the $600 target. What happens is that compared
to dollar cost averaging, you put in more when prices are down, and
less when prices are up.

Dollar-cost averaging takes advantage of the non-linearity of the 1/x
curve (for those of you who are more mathematically inclined). Value
averaging just goes in a little deeper when the value is down (which
implies that prices are down) and in a little less when value is up.

An article in the American Association of Individual Investors showed
via computer simulation that value averaging would outperform dollar-
cost averaging about 95% of the time. "Outperform" is a rather vague
term. As best as I remember, whatever the percentage gain of dollar-
cost averaging versus buying 100% initially, value averaging would
produce another 2 percent or so.

Warning: Neither approach will bail you out of a declining market with
all of your monies intact, nor get you fully invested in the earliest
stage of a bull market.